28 April 2018

Trump Stress-Tests the World Economy

Taking stock of the global economy as finance ministers and central-bank governors gathered in Washington for its spring meetings, the International Monetary Fund found reason for concern. "[R]isks beyond the next several quarters clearly lean to the downside," it reports. Well, that's hardly unusual -- the IMF exists to be concerned. Rarely, though, has it had better grounds. To be sure, much of the world economy has done pretty well lately, with the U.S. leading the way. The IMF's World Economic Outlook projects global growth of roughly 4 percent this year and next, and U.S. growth of 2.9 percent and 2.7 percent -- better than previously forecast. This good news is misleading, though, because it disguises mounting risks to growth and stability. And dangers freshly made in America are high on the list.

The world economy is coming to the end of a catch-up phase. After a prolonged recovery from the crisis of 2008, the current uptick in growth brings many economies closer to full capacity --- when growth must decline to a slower and more sustainable long-term pace. With this point fast approaching, monetary policy remains very loose in the U.S., Europe and elsewhere. That's the first big risk: Shifting back to interest rates consistent with full employment will put stress on economies grown accustomed to cheap money.

The U.S. has compounded this macroeconomic problem by delivering fiscal stimulus the country didn't need. President Donald Trump joined with Republicans in Congress to enact a tax-reform law and a budget that, taken together, will worsen an already bad fiscal position. Ten years after the crash, U.S. government debt still stands at almost 110 percent of gross domestic product. Far from expecting this ratio to decline over the coming years, the IMF projects it to rise further -- to 117 percent by 2023. By then it would be about the same as Italy's debt ratio and almost three times Germany's.

Such heavy fiscal pressure helps growth in the short term but greatly complicates the Federal Reserve's job, adding to the risk that interest rates will rise faster than expected. The hazards arising from the effort to normalize monetary policy would be bad enough by themselves. This fiscal piling on makes matters so much worse.

On top of all this -- and, incredibly, as another deliberate act of policy -- the U.S. government has brought tensions over trade to their worst level in decades.

President Donald Trump has blithely abandoned America's longstanding commitment to open markets and liberal trade, saying he expects to win a trade war easily. He's announced new tariffs, aimed especially at China, and says these will be implemented unless last-minute concessions are made. At the moment, financial markets appear to think he's bluffing (as indeed he may be) or that U.S. trade partners will fold under pressure (also possible). For whatever reason, investors aren't yet taking Trump's trade threats all that seriously.

Again, draw little comfort from this. Sentiment can shift in an instant. If Trump really does start a trade war, at a time when U.S. financial conditions and macroeconomic policy pose risks of their own, watch out. The road back to economic sanity could be bumpy.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net .

No comments: